Friday, March 21, 2008
The Federal Reserve temporarily averted a financial-system meltdown by sponsoring the rescue of Bear Stearns. But the system is still fragile. The best way to shore it up -- without taxpayers providing yet more bailouts -- is to require banks and brokers to raise more capital. This wouldn't be such a problem if the damage were spread evenly. But relatively few victims have suffered. Two-thirds of the subprime write-downs up to the end of last year were taken by just 10 big banks and brokers. These firms retain more than 60% of the world's exposure to subprime assets, and roughly half its stuck leveraged buyout loans, too. Shoring up their capital bases is likely to prove painful. Only a few banks are sitting on big profits from stakes in listed companies, which could be sold if times got tough. And while banks often do have stakes in private companies, these aren't simple to liquidate. Fortis's €2.1 billion sale this week of half its asset-management arm to China's Ping An looks like the exception rather than the rule. Royal Bank of Scotland -- which along with Fortis foolishly extended itself with its top-of-the market purchase of ABN Amro -- has been trying to get rid of its Angel Trains leasing business for months. Hard to sell assets during turburlents market Raising money by floating a business on the stock market also won't be easy, given market conditions. This week's successful initial public offering of Visa, which gave timely cash injections to banks including Bank of America, Citigroup and J.P. Morgan Chase, looks like something of a one-off. Hybrid Captial is teoo expensive Other options for raising capital aren't appealing. Tapping the credit markets for so-called hybrid capital is expensive. British bank HBOS raised £750 million last week at 9.5%, representing a risk premium four times as large as it would have paid a year ago. Sovereign Wealth Fund is not hesitating Selling shares to rich foreign investors might seem an attractive option. And, in the early stages of the crisis, that's exactly what the likes of Citigroup, Merrill Lynch and UBS did. They tapped sovereign-wealth funds in Asia and the Middle East for capital. The snag is that the funds have lost about 40% of the $50 billion they have invested to date -- so they may be reluctant to throw good money after bad. Tap their own shareholder This means that to raise significant capital, financial institutions may be forced to tap their own shareholders. Scrapping dividends, as UBS has done, would help a bit. But a better solution would be to launch deeply discounted rights issues -- as Société Générale did successfully last week to fill the hole left by its rogue trader. Two Portuguese banks -- BCP and BPI -- have similarly got the message and announced rights issues to replenish weak capital coffers. In recent weeks, officials have been ramping up the pressure. Treasury Secretary Henry Paulson has been telling banks to review dividend policies and raise more capital. The mortgage-agency regulator has done a deal with Freddie Mac and Fannie Mae that involves easing some of the constraints under which they operate in return for the companies raising "significant" capital -- although it's not quite clear how much that will be. This pressure probably isn't yet strong enough to have the desired effect. Many financial bosses are reluctant to ask shareholders for bailout money, perhaps fearing that they could pay with their jobs. The authorities need to remind banks that it is better to sacrifice the boss than the whole franchise.